EXECUTIVE SUMMARY

The purpose of this PEFA assessment was to provide an objective analysis of the present performance of the public financial management (PFM) system in Pingjiang County, using the new 2020 Subnational PEFA Framework. The results of this assessment will inform the design of the design of the Hunan Subnational Governance and Rural Public Service Delivery Program-for-Results lending operation and local specific PFM reform initiatives and appropriate technical support from development partners as well as provide a baseline against which the future developments of PFM systems of Pingjiang County can be measured.

The assessment covers the county of Pingjiang, more specifically its government administrative units (GAUs, 行政单位) and public service units (PSUs, 事业单位), including budget-funded service delivery entities such as schools, hospitals, or agricultural service centers. While there is no extra-budgetary unit in Pingjiang County, the social security fund is managed separately from the core budget system—general public budget and government fund budget, and thus is classified as extrabudgetary operation in this assessment. Following China’s legislative classification, state owned enterprise (SOE) is assessed as a public corporation (PC). China laws and regulations prohibit any SOE including local government financing vehicles (LGFV) from financing government investment projects, on behalf of the government. LGFVs that have been undertaking quasifiscal operations are required to be transformed into commercial entities, operating according to market rules, producing goods and services at market price and bearing risks on their own. The government does not have a legislative obligation to bail out any SOE. Considering that they may present potential fiscal risk to the government, Annex 7 provides complementary information on the financial management performance of the LGFV in Pingjiang. At the time of assessment, there was one LGFV in Pingjiang that is still in the process of transformation toward a commercial entity. The field work for the assessment was undertaken from December 15 to 21, 2019 with a follow-up mission from January 14 to 17, 2020. The fiscal years (FYs) covered for indicators that require an assessment of a threeyear period, are 2016 to 2018.

Impact of PFM systems on the three main budgetary outcomes

Overall, the PFM systems of Pingjiang perform well in budget execution, budget reporting, controls, accounting and auditing. The main weaknesses pertain to budget reliability, medium-term budgeting, transparency and fiscal risk control. The context in which Pingjiang sets its budget is important. Pingjiang generally complies with the PFM practices mandated by the central and provincial governments. The lack of predictability of information on transfers to be received from higher-level governments (HLGs) has constrained the county’s PFM performance.

Fiscal discipline

The budget fails to impose fiscal discipline in Pingjiang in some areas. The variation between outturn and budget estimates for both aggregate expenditure (PI-1.1) and expenditure composition (PI-2.1) is rated D, and there are significant budget adjustments for expenditure (PI-21.4, rated D) within the fiscal year. The uncertainty from HLG transfers (the indicator ‘Transfers from HLGs’ is rated D+) contributes significantly to the SNG’s poor estimation of its expenditure. In-year policy changes also make it challenging for the SNG to project its own-source revenue (PI-3, rated C). The fact that the SNG did not use any contingency reserve in the last three fiscal years (FYs) indicates that the SNG is not prudently managing its budget. The in-year resource allocation is frequent and unpredictable (PI-21, rated D), and modern cash management and monitoring for expenditure arrears are missing (PI-22.2, rated D).

Effective control over expenditures by budgetary units helps to maintain fiscal discipline. All government operations are included in financial reports (PI-6, rated A). Payroll control is effectively supported with centralized payment arrangements and auto-reconciliation through an IT system (the first three dimensions of PI-23 rated A). Strong internal control of non-salary expenditure (PI-25, rated B) and an internal audit system (PI-26, rated B+) have ensured strict control over spending during budget execution. A major threat to fiscal discipline is that some important control and monitoring functions lay outside the PFM system. System weaknesses that allow for this threat include the entanglement of government units and the local government financing vehicle (LGFV); the fact that investment financing is delinked from the government budget; that large procurements and contracts are supervised by the Bureau of Development and Reform, not by the Finance Bureau; that expenditure arrears and small procurements are not monitored; that there is no effective supervision of public corporations (PCs); and that, while the Finance Bureau monitors financing by the LGFV, there is no fiscal risk assessment or monitoring of the operations of other PCs. In combination, this suggests a lack of institutional mechanism for ensuring hard budget constraints. Consequently, off-budget borrowing may arise. The lack of public scrutiny of financial assets, liabilities, PCs and investment projects is seen as an additional threat to fiscal discipline.

Strategic allocation of resources

The main PEFA indicator concerned with medium-term budget strategy (PI-14) is rated D+. Though some macroeconomic indicators have been considered for budget preparation, there is no medium-term budgeting framework, and the fiscal impact of policy changes is not regularly estimated. In addition, costing information on major investment projects is not included in the budget documents (PI-11.3, rated D). The oversight arrangements with a view to the budget preparation process and legislative scrutiny of the budget, are assessed as reasonable (PI-17, rated B and PI-18, rated C+).

Other indicators that relate to the strategic allocation of resources are rated as satisfactory. Clear rules for prioritizing major investments are in place (PI-11.2, rated A). Budget documentation (PI-5, rated C) meets most basic requirements, though economic classification is not fully adopted in the government budget accounting (PI-4, D).

Efficient use of resources for service delivery

The PFM systems of Pingjiang encourage the efficient use of resources for service delivery. To this end, the budgetary units in Pingjiang regularly publish performance targets (PI-8.1, C), conduct performance evaluation (PI-8.4, C) and report available resources (PI-8.3, A). However, low budget reliability and predictability of inyear resource allocation (PI-21, D) may adversely affect the capacity of service delivery units to make efficient use of resources.

Many required mechanisms are in place to reduce the possible leakage of funds, such as the asset management system (PI-12, B) and the internal control mechanisms for payroll (PI-23, C+) and non-salary expenditures (PI-25, B). As for the procurement management system, data are not available to evaluate procurement monitoring (PI-24.1, D*) and procurement methods (PI-24.2, D*), but there is reasonable information disclosure (PI-24.3, C) and a sound complaint solving regime (PI-24.4, A).

The ratings of the existing oversight arrangements are mixed (D+ for PI-30 and B for PI-31). The external audit reports were submitted to the People’s Congress within six months. The required follow-up actions were taken by related entities effectively and timely. The audit reports were published on the government’s website for the last completed FY. However, the coverage of external audit is low, and hearings on audit reports were not accessible to the public.

The overall impact of PFM on the efficient use of resources for service delivery is not clear as performance achieved in service delivery is not published (PI-8.2, D).

In sum, the Pingjiang PFM systems perform at sub-optimal level. With the right regulatory framework set by the central and provincial government, there is great potential for improvement.

The assessment results shall be interpreted with an important caveat in mind. As the Annex 7 shows, LGFVs carried out sizeable quasi-governmental activities while operating outside of the PFM system (Annex PI-6, D).

The Pingjiang Government has basic monitoring authority over the investment project that LGFVs implement (Annex PI-11.4, C) and their liabilities (Annex PI-13.1, B). A comprehensive assessment for LGFVs is warranted to reveal the impact of LGFVs on the PFM performance of Pingjiang County.

China has launched ambitious fiscal and taxation reforms since 2014. The revised landmark Budget Law and its associated directives have laid out a solid foundation for a modern fiscal framework. The main motivation has been to better serve the transformation of the government functions from boosting growth more toward delivering quality public goods and services. The major changes mandated by the revised Budget Law fall into five areas: 1) making the budget comprehensive and transparent; 2) improving credibility and mediumterm perspective of the budget; 3) allowing provinces to borrow on budget within the regulatory framework; 4) making transfers transparent, fair and pro-equalization; and 5) hardening budget constraint. The recently released Government Investment Decree, if effectively implemented, could enhance the discipline and scrutiny around government investment projects and contain contingent liabilities associated with their financing.

The reforms that are currently being pushed by the Central Government (CG), and fully embraced by Hunan Province, provide a good opportunity and foundation for the county government to carry out the needed PFM reforms. PFM in China is a long-term endeavor, requiring the concerted effort of all tiers of government and coordinated adaptation of all public-sector institutions.